I’m getting a lot of mail from readers. Seems Riedl’s post has stirred up a hornet’s nest. I will be happy to post some replies from our readers. I didn’t intend to post any that covered more than one Riedl myth at a time, but this one seems to do it well…

“The best way to measure the swing from surplus to deficit is by comparing the pre–tax cut budget baseline of the Congressional Budget Office (CBO) with what actually happened. … [In 2006,] 90 percent of the swing from surplus to deficit resulted from higher-than-projected spending, and only 10 percent resulted from lower-than-projected revenues.”

That result also appears to be unique to 2006. Here is that same analysis presented over all of 2002-2006. (The first column is the percentage of change from baseline resulting from higher spending, the second is the percentage resulting from lower revenues.)

We know that the economy did not double in size between 2003 and 2006 — it grew at about 2.5% per year in real dollars. So what we are seeing here is mostly the fact that capital gains taxes vary a lot by reason of the business cycle, not any great macroeconomic lesson about how capital gains taxes supposedly pay for themselves. There’s no reason to think that if capital gains taxes had been left alone in 2003, capital gains tax receipts in 2006 wouldn’t have been something more like $134b.

(Amusingly, this Myth #4 immediately follows Myth #3: Supply-side economics assumes that all tax cuts immediately pay for themselves. Fact: It assumes replenishment of some but not necessarily all lost revenues. Alas, the supply-siders just can’t resist the temptation.)

PGL has had a number of posts in which he notes that cutting tax rates without cutting spending is little more than defering taxes. Reader T-bone (reachable at tim of mars, all one word, at gmail) sends some additional thoughts:

Regarding looming deficit, it seems Bush has given tax breaks but without decreasing spending. This seems like having your cake and eating it too regarding economic growth. Shouldn’t we be booming with economic growth with this unsustainable policy? When people point to minor inprovements in growth to support this policy, all I can think is “You expected worse???”. So this current economic policy answers the question of what is better, spending increases or tax breaks, with the answer: BOTH!

I would bet if we had to substitute some spending to pay for the bush tax cuts to keep a balanced budget, the economic growth would decline compared to no cuts and keeping the spending. Though to prove why spending is generally more efficient would require another in depth analysis that strays from this topic. But the short answer is that spending tends to employ new people either who had no income or who now give up their previous jobs to someone who had no income, which is similar to a tax break for the poorest. I’ve also argued elsewhere that the spending habits of the people with less money tends to instantly create demand when given more money, whereas wealthier people tend to store the money in a banks/investments, which increases investment availability, not demand.

Regarding the relevance to the actual needs of the country, I also have some theories on the “quality” of the growth of GDP that comes from tax breaks for the wealthiest.

For example, what added benefit would we get if a wealthy person uses his newfound wealth to get a custom made car that takes 15 times the effort and personel to create compared to the production-line stamped-out lexus he would have bought without the tax cut? Or what if he just hired a few more servants to wipe his butt? The only real benefit is that it employed a few people for a while. And this is only in cases where the wealthy person has spent the money rather than saved it.

How is that end result different from if the government employed some people to sit around all day. Money still gets to the people who will spend it on the more efficiently created goods, except now the wealthy guy has to wipe his own butt. And imagine if those government employees actually were employed to serve the public in ways that do not compete with private sector goods and services.

You know, for all this talk about recession, (with some pundits calling for a recession just about every year – Paul Krugman comes to mind), the reality is that economic growth has been steady and strong following the 2001-2002 recession. Think lower marginal tax rates, implemented in 2003 to strengthen work incentives, and significantly increase after-tax investment rewards. This is Goldilocks plus. It is called free market, Milton Friedman capitalism – with a strong dose of supply-side guru Art Laffer.

First of all, Paul Krugman does not “call for a recession” every year. Secondly, while Kudlow’s 3.5% overall real GDP growth claim was borne out this morning, he really should have waited for the details before he claimed investment demand would be strong. Overall, fixed investment demand seems to be falling at an 11% annualized rate. This is mainly due to declining residential investment but also due to a slip in business investment. So it was left to a growth in net exports, consumption growth being at a 4.4% clip, and government purchase growth being at a 3.7% clip. As far as Federal government purchases, it seems nondefense purchases fell while the DoD is spending growth is strong. So Larry can cheer about all those new defense expenditures as national savings continues to decline. Not exactly the free market that Milton Friedman envisioned.

When people across the world look at America’s economy what they see is low inflation, low unemployment, and the fastest growth of any major industrialized nation. The entrepreneurial spirit is alive and well in the United States. There is one undisputed leader in the world in terms of economy, and that’s the United States of America … Our economic leadership also depends on sensible, pro-growth tax policies. To help bring our economy out of a recession and recover from September the 11th, we cut taxes on the American people. We cut taxes on everybody who pays income taxes. We doubled the child tax credit. We reduced the marriage penalty. We cut taxes on small businesses. And we cut taxes on dividends and capital gains. There’s a lot of political debate about these tax cuts. But here are some of the facts: Since we enacted major tax relief into law in 2003, our economy has created nearly 7.2 million new jobs. Our economy has expanded by more than 13 percent. That expansion is roughly the size of the entire Canadian economy. This economic growth has led to record tax revenues, which has helped us cut the deficit in half three years ahead of schedule. One fact should be clear when you look at the statistics: The fastest way to kill a recovery would be to raise taxes on the people who created it. Now is not the time for the federal government to be raising taxes on the American people. We must ensure that the money you send to Washington is spent wisely. Next Monday, I’m going to submit to Congress a budget that will eliminate the deficit by 2012. In order to do so, we need to set priorities in Washington. You can’t try to be all things to all people when it comes to spending your money if you want to keep taxes low, keep the economy growing, and balance the budget.

Pardon my interruption but President Bush has been “all things to all people” with his Spend&Spend and Borrow&Borrow fiscal policy. Now the President babbles on as to how he wants to cut spending and reduce trade barriers, but then I have to wonder- who was that fellow acting as President over the past six years? There was also a long discussion as to health care policy followed by his desire to spending more taxpayer money to develop sources of energy other than imported oil. Oh yea – back to the trade protectionist big spending we used to know as our President. Bush also says we should spend more funds on education and resource. You see – a “Big Government Conservative” never has to choose between spending more versus taxing less. After all – that promise to balance the budget. It’s all smoke and mirrors funded by the Social Security Trust Fund reserves.

When Cactus commented on the first myth from Brian Riedl – for a moment I thought we’d discovered the true identity of the troll who calls himself Patrick R. Sullivan (or was it Roland Patrick or the host of other names he uses to attack the comment box of Brad DeLong’s blog). Riedl writes:

Tax revenues in 2006 were 18.4 percent of gross domestic product (GDP), which isactually above the 20-year, 40-year, and 60-year historical aver­ages … While revenues as a percentage of GDP have not fully returned to pre-recession levels (20.9 percent in 2000), it is now clear that the pre-recession level was a major historical anomaly caused by a tempo­rary stock market bubble.

Our favorite troll makes the same claims as he tries to argue that it’s not possible to have taxes be more than 19% of GDP for a sustained period of time. Our graph shows the ratio of taxes to GDP as well as the ratio of Federal spending to GDP from 1946 to 2005. While it is true that the average tax to GDP ratio for this 60-year period is just over 18%, which was the tax to GDP ratio for 2005, there are several problems with this abuse of a 60-year average. First of all, the tax to GDP ratio was very close to 20% during both the late 1960’s and in 1981 (before the Reagan tax cut and Reagan recession) so this anomaly claim is just false. We should also note that the tax to GDP ratio exceeded 19% for the six year period from 1995 to 2001.

Also notice that until the 1970’s, Federal spending as a share of GDP typically was below 19%. In fact, it was typically below 17% of GDP during the late 1940’s and during the 1950’s. While the Truman and Eisenhower Administrations wanted to pay down the Federal debt accumulated during World War II, they didn’t need taxes to be 20% of GDP in order to do so.

What Riedl also fails to admit is that the reductions in the taxes collected relative to GDP after 1981 and after 2001 have led to increases in Federal debt, which are deferred taxes. Riedl wants us to believe that Federal spending as a share of GDP is high relative to historical standards. Well – if by historical standards include the 1920’s and the 1950’s, he’s right. But if he is referring to the period since 1970, he’s is not correct.

Finally, Riedl forgets to mention the change in the composition of Federal tax revenues. Over the past 20 years, we’ve collected more in the form of payroll contributions that in part were supposed to be establishing a Social Security Trust Fund reserve to pay for those retirement benefits of the Baby Boomers. Alas, we have been collecting less in the form of income taxes. I would expect a rightwing troll to admit this – but someone who works for the Heritage Foundation should. So why didn’t Mr. Riedl acknowledge any of this?

Update: Max Sawicky comments on Riedl’s 10 myths by first saying it is one of the dumbest things he has seen coming out of Heritage and then this:

The real myth is that anyone over there knows what the hell they are talkingabout. One reason it is stupid, apart from the economic misinformation, is theassumption that the reader is stupid – that he cannot see through the transparent weasel logic.

In other words, it’s like most of garbage put forth by the National Review.

wonder, did they calculate the average dating back to independence in 1776 or only back to the constitution taking effect in 1789? In related developments, a twelve inch black and white television has better picture quality than a player piano and our troops in Iraq are only insufficiently equipped if you forget that the historical average indicates that soldiers typically rely on horse-drawntransportation.

Reader Steve Miller pointed me to an Andrew Sullivan post. Sullivan states: “Some things the left won’t tell you” and then produces some quotes taken from this, um, write-up by Brian M. Riedl at the Heritage Foundation entitled “Ten Myths About the Bush Tax Cuts.” I don’t have time to look at all of these now, but I’ll start with “Myth 1” and cover other “myths” in later dates.

this document and tells us to reference OMB Table 1.3 to make a point. Note to Riedl – its easier to work with the data when its not in PDF format – look here instead.

So, without further ado… “Myth #1: Tax revenues remain low.Fact: Tax revenues are above the historical average, even after the tax cuts.”

Now, he links to this document this document and tells us to reference OMB Table 1.3 to make a point. Note to Riedl – its easier to work with the data when its not in PDF format – look here instead. Anyway, wherever you check, this morning OMB Table 1.3 shows estimated tax revenues for 2006 to be 17.5 percent. Now, I wouldn’t trust the estimated figures, especially when coming out of this White House, but Riedl is not getting his figure from where he tells us he’s getting his figure. 18.4% is not 17.5%. Perhaps 18.4% is an 11th myth he forgot to number?

Continuing… when I take the average 20 year receipts (1986 to 2005), they are in fact 18.4%, which is higher than the receipts in 2002, 2003, 2004, 2005, and the estimated receipts in 2006 (17.9%, 16.5%, 16.3%, 17.5%, and 17.5% respectively). 40 year receipts – 18.3%, were also higher than for each year since 2002. 60 year receipts were at 17.9% – now we’re getting somewhere. GW actually managed to equal the 60 year average… in 2002 before the worst effects of his tax cuts really took hold.

Even if it turns out that receipts do rise in 2006 to 18.4% – I wouldn’t be crowing about a single outlier year if I were Riedl, or Sullivan for that matter, but then, I’m neither one, for which I am very thankful. When I have time, I’ll look at the other “myths” Riedl wrote about. I’d suggest Riedl do the same, but then again, he works for the Heritage Foundation, and no doubt he wants to keep that gig. Its easier than looking at what the data actually says.

Update… Reader Rana suggests that the data comes from the CBO. CBO Table 1-3 does indeed show tax receipts at 18.4% of GDP, so Riedl’s figure for 2006 is correct, even if the source he gives is wrong.

Comparing the CBO figures to data from previous years at OMB Table 2.3, we find that individual tax receipts are up … almost to the point they were in 2002. Corporate tax collections are at 2.3 percent – they haven’t been above 2 percent since the year 2000. As I noted in other posts, this probably has more to do, paradoxically, with the IRS willingness to forgive past tax evasion in exchange for some amount of current payment. “Other” is also at quite a high – apparently some sort of hidden taxes – things like fees and so forth.

So… a second look at this myth… Riedl is partly right… tax receipts are once again, after several awful years, back at their 20 and 40 year averages. If they remain this way, at least for two or three years, when it comes to tax collection, the last few years of GW’s term will be, well, average. That is… if they remain this way. Considering GW’s performance in other areas, I can see why Riedl is excited.

As a follow up to my post on Monday about measuring instability, let’s say one wants to measure the potential for democracy or “democratic reform.” Consider… the US has for a long time had good relations with Saudi Arabia. In many ways, the relationship has gotten, well, gooder, under GW. Signs of this range from our President holding hands with Abdullah (my suspicion is that GW has never held hands with any man since he was three, and if one were to say he was respecting Abdullah’s culture, well, in many parts of the world men greet each other with a kiss – and we haven’t see GW do that at all) to Cheney’s getting called on the Saudi carpet when some idiots in the administration were contemplating the “20 percent solution”

The US relationship with Pakistan has also gotten significantly gooder under GW. I’m just thinking of how small the price has been for Pakistan to pay for Khan’s transfer of WMD technology to rogue states. I’m thinking that since it was all accomplished on official Pakistani aircraft, and since Pakistan won’t let US agents talk to him, the Pakistani government must have been more involved than the official story. I also think about how its general knowledge that at a very minimum, elements in the Pakistani security services are helping the Taliban.

So the question… why is the US being so friendly these and other states run by people that hate us and do what they can to hurt us. Let’s leave out conspiracy theories, and take GW at his word. He claims he’s all for supporting the forces of democracy. Let us assume he believes these countries are becoming more democratic.

Now, leaving GW out of this, how would one objectively quantify whether a leader of a country, or even the country as a whole, is ready to become more democratic?

Hoisted from comments. Reader T-Bone on Economics (with a couple minor edits to extricate it from the longer comment):

I felt like I knew economics before I ever even had a class on economics, even though I may not have known any of the terms like M1, supply side economics and such. All of economics is just a study of human behavior and decision-making in the face of different circumstances. There are plenty of important things that generally aren’t mentioned in most economics classes, the intangibles. Maybe economics is best taught in conjuction with philosophy.

Perhaps one advantage of not learning economics formally is that you need everything proven logically. You don’t read about economic “truths” and just take them as undeniable fact. You need to have it proven. Otherwise, I might believe that tax cuts are a cure-all that always boosts economic growth. Trying to figure out why that might be the case leads to breaking down that argument into each of the small steps that make it up, and examining how people in different situations react to the changes. So that’s my advice to those who think they don’t know economics. Break everything down into small cause-and-effect steps, apply it to real people and yourself rather than a generalization of people, and your conclusions will be correct unless you missed an important factor.

I understand that recently Christie’s auctioned off some treasures that the Greek government feels may have been illegally removed from Greece. I’m something of a Philistine when it comes to art – I can tell from looking if something is a Henry Moore or a Rodin, but frankly, I have no appreciation. Most art just doesn’t do anything for me.

But the story did get me thinking about stolen property. Art, I understand, is easy to trace. Let’s talk, I don’t know, diamond earrings. I assume that if I were to purchase a pair of diamond earrings, and it turned out to be stolen – the item would go back to its rightful owner. But what about the money I paid for the property? Is the seller (and from here on, I’m assuming all the seller was equally innocent of the items provenance) supposed to reimburse me? And is the person he/she bought it from supposed to reimburse him/her? I’m not an attorney – perhaps one of our readers that is might inform the rest of us.

But… the answer to the reimbursement question presumably says something about incentives as well. If the buyer of stolen property takes the entire hit (i.e., the item is seized by the rightful owner, and the buyer is not reimbursed), it increases the incentive to ensure that items one buys are not stolen, but decreases the incentive to ensure that items one sells are not stolen. (Also… buyers are then encouraged to turn around and resell quickly.) If the seller takes the hit (i.e., is required to reimburse the buyer for items seized by the rightful owner), selling stolen property becomes discouraged, but not buying it. Thus – one has a greater incentive to buy and hang onto stolen property.

So… which approach (penalizing buyers or sellers) is more likely to lead to less theft? In the first transaction, the buyer is buying from the thief. The thief is obviously not discouraged by engaging in an illegal act, given that he/she is a thief. The odds of the thief being willing or able to reimburse the buyer upon seizure of the property are minimal. Thus, the first buyer, at least, will take a hit, no matter how many further transactions occur. And all else being equal, the first buyer in a chain of transactions is also the one most likely to be able to spot the potential problem. Increasing the penalties on this first buyer may be the best way to reduce thefts.